When a stock, or any other investment, has a yield as high as Pacific Coast Oil Trust (NYSE:ROYT) and pays distributions on a monthly basis, there aren't many expectations that the stock price will grow that much, if at all. However, an investor with even modest expectations would hope that an investment would perform better than what this trust has done since its inception back in 2012:
This kind of performance is not just bad luck, though -- it has a lot to do with the fact that it is a royalty trust, and doesn't necessarily mean that it's a horrible investment. Let's take a quick look at the Pacific Coast Oil Trust, why it has performed the way it has in recent years, and whether it's a stock for those looking for monthly income.
A refresher on royalty trusts
Before getting specifically into the Pacific Coast Oil Trust, let's go over a couple quick things about trusts in general. The most important thing to remember is that they are not companies. They represent direct ownership of a property that produces natural resources such as oil and gas. What this means is that you, the investor, are entitled to a certain percentage of the revenue from the producing assets on that property.
This unique position has its benefits and drawbacks. One advantage is that these trusts are exempt from corporate taxes because they are pass-through entities, much like master limited partnerships. But unlike an MLP, where you pay income taxes on cash distributions, royalty trust distributions are capital gains and not income. You also get the benefits of depreciating those assets to lower your cost basis to delay taxes.
The disadvantage to this position, though, is that there is no company in between you and the price of oil and gas. Unlike a company that can use futures contracts to protect the price of oil it sells down the road, Pacific Coast Oil Trust sells all of its oil and gas on the spot market, so any price change will immediately impact the size of cash distributions each month. So take a look again at the price chart for Pacific Coast Oil, then look at this chart tracking the price of Brent crude oil. With the price of Pacific Coast Oil's sole revenue driver dropping almost 30% since the inception of the trust, that decline in value makes much more sense.
Also, unlike a company, a royalty trust's value will eventually go to zero as its resources are exhausted. Once a royalty trust meets its termination conditions -- in the case of the Pacific Coast Oil Trust if it cannot meet a cash distribution of $2 million annually for two years -- it is liquidated and the sale value is distributed to the unit holders in the trust.
The skinny on the Pacific Coast Oil Trust
Pacific Coast Oil Trust is one of the newer trusts out there. It was formed only two years ago and went public in May of that year, so it doesn't exactly have the track record that many other oil and gas trusts have in the market today. That's fine, though, because the three major points you need to know about the Pacific Coast Oil Trust are the same as any other trust: its production mix, its estimated remaining reserves, and its payback period.
If you are investing in this particular trust, you are making almost a pure bet on oil. Production from this particular trust is 97% oil, and the revenue generated from oil sales is more than 99% from oil. Since all of the property interests held by the trust are in California, most of the oil is sold at the international Brent price rather than domestic West Texas Intermediate prices, which has been the more lucrative price to have for the past several years. Pretty much all of the oil in this trust comes from proved, developing properties using water and steam flooding to maintain production. There are several million barrels of oil in some of the trust's undeveloped properties, but the conditions of the trust stipulate that the working interest in these fields is very small and the development of these new fields will do little more than offset the decline from its developed properties.
Still, based on the current production and reserves, it will take more than 20 years until the fields held under the trust are completely depleted, which is one of the longest shelf lives for a trust out there today. What makes this even more encouraging, though, is that at the trust's current dividend yield of 15.6%, it will only take 6.4 years to pay back your original investment. Keep in mind, though, that these numbers are a reflection of oil prices that have been considerably higher over the past 12 months than what they are today. If prices were to remain at today's levels for an extended period of time, these numbers could change drastically.
What a Fool Believes
Despite the chart above, Pacific Coast Oil actually looks like one of the most attractive royalty trusts out there because of its long anticipated shelf life, its link to international pricing, and its estimated payback period. The one thing that is challenging about investing in this trust is that it's a long-term bet on oil prices. That's tough, because its almost impossible to predict the price of oil. If you are looking for a steady income check on a month to month basis, then Pacific Coast Royalty or any other royalty trust is the wrong place to look. However, if you have the flexibility to sit on shares for a long time let those cash payments reinvest, then Pacific Coast Royalty could hold some long-term value.